Tesla’s Intriguing China Strategy

Tesla’s share price has been on a tear over the past couple of days, first on (somewhat laughable) rumors of an Apple takeover and then today based on an earnings release that saw falling production costs and rising gross margins.

But the most interesting part of the shareholder letter (PDF) is the one that addresses an issue keeping margins down. Tesla’s pricing strategy in China. The Model S is a very expensive car in the United States. And in China, it’s even more expensive. But the standard practice for luxury automakers is to charge drastically higher prices in China than in North America or Europe—believing that the China market can support higher margin sales. Tesla, by contrast, only charges a bit more in China than in the U.S. to compensate for taxes and transportation charges:

We strive for transparent and fair pricing in every market. Consistent with this goal, the price for a Model S in China is the same as the price for a Model S in the US, adding only unavoidable taxes, customs duties and transportation costs. We are taking a risk with this strategy, because it is counter to prevailing auto industry practices. Still, we believe it is the right thing to do. It also means that in China the Model S is priced comparable to a mid-sized premium vehicle, instead of a large luxury vehicle.

As I wrote in my piece about Amazon, one should think of this kind of pricing strategy as an investment. Where other luxury brands see an opportunity to pad margins by gouging Chinese customers, Tesla sees a still-maturing market where it can earn goodwill and brand loyalty by eschewing that kind of behavior. This is the kind of thing you can get away with when your company is a hot growth stock that’s already priced at a massive price-to-earnings ratio. Tesla investors are buying the future in a way that BMW investors aren’t, so a China pricing strategy that’s oriented to the future makes sense.